The US debt, refuge value of the world economy close to a default

Without a quick agreement to increase the debt limit, the government of USA will not be able to meet its obligations, alerted the Secretary of the Treasury, Janet Yellenwith the risk of an unprecedented default.

What can happen from the first of June?

The date is the first of June or, more broadly, to “beginning of June” as Yellen stressed. Specifically, it is from that moment that the exceptional measures adopted since January, when the country’s debt limit established by Congress was reached, will no longer be sufficient.

Without an increase in the capacity to issue debt or the suspension of the call “debt ceiling”the federal government will not be able to honor all its obligations and should give priority to the most important ones, debt maturities in the first place, precisely to avoid a moratorium.

You must therefore reduce, delay or simply not make other expenses

The potential consequences are very concrete: delay in payment to government providers, temporary reduction in pensions, delay in the payment of social assistance benefits and in the payment of public salaries.

How do you know if a country is in default?

A default or moratorium occurs when a State does not meet a payment deadline to its creditors, regardless of whether it is capital owed or interest linked to the credit contracted. The amount at stake may be modest but non-payment may constitute a partial or total default.

The government can declare itself in default by announcing that it will not pay debt maturities. The announcement may also come from a financial ratings agency after a 30-day grace period, and entails a downgrade of your credit score.

The United States has the highest possible score and its credit is considered totally safe.

A private creditor can publicly denounce that a country has stopped paying it. The moratorium can also be found through the US agency ISDA (International Swaps and Derivatives Association), which regulates CDS, a kind of insurance against defaults.

Who owns US debt?

In the American collective imagination, the debt is essentially in foreign hands and the first place in the list of creditors is occupied by China, followed by Japan. But in fact, the situation has some nuances: out of a total of 31 trillion dollars, only 7.4 trillion is in foreign hands, according to Treasury data. Of that total, only 859,000 million are held by China, that is, 2.7% of the US public debt.

This total concerns both central banks or foreign governments and financial institutions located outside the United States. For this reason, 285,000 million have “campus” in the Cayman Islands.

More than 75% of the US debt is held by national economic actors. And more than 12 trillion dollars are in the hands… of the government, federal agencies or the Fed itself, the Federal Reserve or US central bank. This is almost 40% of the total public debt via the pension funds of civil servants.

The rest, almost US$11.6 trillion, is in the hands of private Americans such as banks, insurers, pension funds and to a lesser extent (US$160 billion), individuals.

If there were a default, what would be the impact on the US and world economy?

Before a default, the need that the government will have to adjust its spending will have a direct impact on the country’s economy: there may be civil servants in technical unemployment, an increase in precautionary savings… all measures that will reduce the amount of money that comes to the economy.

With a default, it is another level of difficulty that the country would face, since it implies a net loss for the creditors concerned and also a fall in the value of the asset. “US debt”which could destabilize some holders.

There is also an automatic rise in credit costs for the country, companies and individuals.

The effect on financial markets would be immediate, with the possibility of a stock market crash as a result of general concern.

In the event of a default for three months, the White House expects a loss of 6.1% of GDP in 2023 and the destruction of 8 million jobs.

A shorter moratorium would have a more limited effect, but it would still mean 500,000 jobs and a contraction in GDP of 0.5%.

There would also be a huge effect on investor confidence in the US’s own debt. The fact that the country has always honored its obligations has made the US debt a refuge value in the world economy, and contained the cost of borrowing for the country, which, due to this confidence, can pay less interest to finance itself.

Impossible then to know the potential consequences if this certainty is ended.

Source: AFP